CUTS' Memorandum to the Hon’ble Finance Minister

Discussion on ‘Food Subsidies’
25th May 2005, New Delhi

The National Common Minimum Programme (NCMP) of the Government, inter alia, states:

The UPA government will strengthen the public distribution system (PDS) particularly in the poorest and backward blocks of the country.

Special schemes to reach foodgrains to the most destitute and infirm will be launched. Grain banks in chronically food-scarce areas will be established. Antyodaya cards for all households at risk of hunger will be introduced.

The UPA government will bring about major improvements in the functioning of the Food Corporation of India (FCI) to control inefficiencies that increase the food subsidy burden.

All subsidies will be targeted sharply at the poor and the truly needy like small and marginal farmers, farm labour and the urban poor.

The objectives of food subsidies in India are to maintain price stability; provide support to poor; and ensure adequate returns to small and marginal farmers.

Food subsidies in India comprises:

  • Subsidies to farmers through minimum support prices (MSPs) and purchase operations of the Food Corporation of India;
  • Consumer subsidies through the public distribution system, and
  • Subsidies to FCI to cover all its costs.

According to the Ministry of Finance report on ‘Central Government Subsidies’, the food subsidy bill has gone up by 10.5 times from Rs.2450 crore in 1990-91 to Rs.25,800 crore in 2003-04. As a proportion of GDP, it has gone up from 0.43 to 0.93, over the same period.

The main benefits of food subsidies are food security provided to citizens, particularly the poor, and incentives to farmers to keep foodgrains production at a comfortable level. However, there are distortions in the way food subsidies are delivered, leading to mounting food subsidy bills, without commensurate benefits to target beneficiaries.

It has been estimated that the cost of transferring a rupee to the poor through the PDS is Rs.6.68 and that administrative costs account for 85% of the total expenditure. Between 1957-90, the administrative costs increased by 274%. Government studies of the PDS suggest that only 25% of the grains actually reach the poor.

This note critically reviews the policy options suggested in the report prepared by the Ministry of Finance, with the aim of ensuring that subsidies are transparent, well targeted, and suitably designed for effective implementation without any leakages.

I. Subsidies to FCI to cover its costs

Concerns/Distortions

Suggestions made in the report

Remarks

  • Purchases of the FCI are open-ended (i.e. it has to accept all the grains that are sold to it at the declared purchase price).
  • Since the issue price and the purchase price are linked, higher purchase prices result in higher issue prices. With relative high MSPs, procurement has been high and off-take low resulting in a build-up of stocks, adding to the subsidy bill.
  • With a large part of the marketed surplus in FCI warehouses, lower market supply exerts upward pressure on prices in the open market, neutralising much of the consumer benefits that subsidy provides.
  • To run the excessive stocks down, foodgrains are often exported by providing exporters, foodgrains at near BPL prices.
  • The MSP should correspond to the CACP-determined cost (in other words, reduce MSP)
  • Purchase operations should not be open-ended. Before every sowing season, procurement targets should be fixed. FCI should suspend purchase operations once targets are achieved.
  • A system of price insurance may be developed. The scheme should be self-financing and without any subsidy obligation. This can operate in conjunction with the purchase operations to benefit those farmers who miss out on the opportunity of selling their surplus at the support price because of the close-ended purchase operations.
  • The suggestions to reduce MSP and make purchase operations close-ended will certainly reduce the subsidy bill. However, it would not ensure that the subsidy is targeted sharply at the truly needy i.e. small and marginal farmers.
  • Another way to reduce subsidy bill is by not using the same instrument to serve conflicting objectives. Presently, the food subsidy policy seeks to achieve through the MSP-PDS operations, the conflicting objectives of ensuring remunerative price to farmers and providing foodgrains to poor at affordable prices. By implication, this entails a huge gap between the purchase price and issue price, and consequently a larger subsidy bill.
  • All costs of FCI are automatically reimbursed, and there is little incentive to raise efficiency and reduce costs.
  • Reimbursement of costs to FCI should be based on normative unit costs and actual quantity involved, instead of reimbursement on actual basis.
  • Some functions of the FCI can be outsourced.
  • Move towards decentralisation of procurement to usher in greater efficiency in the purchase and distribution operations
  • The role of the Food Corporation of India need to be clearly defined, particularly in the context of decentralisation of procurement.
  • There is need to specify how individual state targets would be determined in the context of decentralisation of procurement.
  • Concentration of FCI purchases in a few States facilitates tax exportation by some of these States. For instance, Punjab and Haryana impose mandi fees on the purchases of foodgrains. With FCI paying such taxes, the tax gets exported to consumers in other States.
  • The tendency for tax exportation by some States needs to be curbed, by appropriate legislation. Since it is easy to identify the States that indulge in this practice, differential purchase prices can be worked out for individual States.
  • There should be definite criteria for working out differential purchase prices for individual states, lest it would be subject to political exigencies, particularly in the present coalition era.
  • FCI has been involved in price support operations for jowar, maize and bajra. The quantities are becoming larger each year and storage losses are heavy because of limited shelf life. It has proved to be difficult to sell these coarse grains through the PDS and the bulk of the procurement has been sold, at heavy loss, as cattle feed.

  • Coarse grains should not be included in PDS operations since their shelf life is limited and they are available at low prices to the poor.

II. Consumer Subsidies

Concerns/Distortions

Suggestions made in the report

Remarks

  • The targeted public distribution system (TDPS) has introduced a dual price system. The same shopkeeper sells the same grain to different classes of consumers at different prices. The system is thus open to corruption.
  • Food coupons may be introduced to initially cover only the additional subsidy given to the below poverty line (BPL) families over and above that for above poverty line (APL), while continuing with the exclusive PDS outlets.
  • The BPL families would then pay the PDS outlet the same price as the APL families, but partly with coupons and partly in cash.
  • Gradually the system could be extended to any foodgrains seller even outside the fair price shops.
  • While on one hand the suggestions seek to eliminate the dual system of prices in PDS, at the same time a dual system for distributing foodgrains is sought for BPL families – food coupons as well as ration cards. This may create distortions.
  • Once the system is extended to foodgrains seller outside the fair price shops, no separate ration shops would be required.
  • There are both inclusion and exclusion errors, and large-scale diversion of foodgrains from the PDS/TPDS network.
  • According to a study by Tata Economic Consultancy Services, about a third of TDPS supplies were diverted and did not reach the intended beneficiaries.
  • The NSS data on PDS consumption are generally lower than the official data on PDS supply. This may reflect leakages from the PDS.
  • Bulk of the foodgrains is pilfered and sold in the market or damaged due to poor storage conditions.
  • Self-targeting in PDS can be brought in by:
  • Subsidising coarse grains consumed generally by poor alone
  • Locate PDS shops in areas where the poor live.
  • Allow PDS grain purchase on a weekly basis rather than monthly basis.
  • Measures suggested to plug leakages (food coupon system for BPL families) and improve targeting (self-targeting) would have very limited impact in addressing the various concerns.
  • Food coupon system, as suggested, will not help solving the problem of foodgrains being sold in the black market.
  • Coarse grains should not be included in PDS operations since their shelf life is limited and they are available at low prices to the poor. Though effective for better self-targeting, the suggestion is not worth implementing given the associated costs.
  • The monitoring and vigilance system proposed in the TPDS guidelines, which were to involve local Panchayati Raj institutions (PRIs), has not become operational.
  • A CAG beneficiary study found non-awareness of entitlements among consumers. The study reported the absence of grievance redressal systems.

  • PRIs/NGOs should be involved in design, implementation and monitoring of location-specific food distribution/security systems. They should be entrusted with the task of identifying the beneficiaries. They should be roped in to create awareness among consumers about their entitlements under the programme.
  • Grievance redressal system should be established.
  • NGOs should conduct social audit of the schemes, and report misuse of funds.
  • There are wide disparities in PDS penetration in different States.

  • Food coupons in areas not adequately covered by fair price shops could be introduced

III. Subsidies to Farmers

Concerns/Distortions

Suggestions made in the report

Remarks

  • FCI’s purchase operations are mainly confined to five states – Punjab, Haryana, Western UP, Andhra Pradesh, and Chhattisgarh. This has led to concentration of farmers’ subsidy to these States. In fact, a large percentage of farmers in these states are not poor.
  • Exclusive attention to wheat and rice has distorted the cropping pattern of farmers in favour of these two foodgrains alone.
  • Move towards decentralisation of procurement to distribute the benefits of price support operations more evenly across the country.
  • Though decentralisation of procurement would ensure that benefits are distributed more evenly across the country, but how will it ensure that these benefits are actually availed by small and marginal farmers and not cornered by rich farmers.
  • There is a need to involve local level agencies such as PRIs/NGOs to ensure proper identification of beneficiaries and monitoring of the scheme.

 

Alternative Procurement System Proposed

At present food subsidy policy uses the same instrument to achieve the conflicting objectives of ensuring remunerative price to farmers and providing the foodgrains so procured, to poor at affordable prices. By implication, this entails a huge gap between the purchase price and issue price, and consequently a larger subsidy bill.

Instead the following two-tier procurement system is suggested:

  • MSP operations to provide support to small and marginal farmers and use the foodgrains so procured to maintain buffer stock to ensure price stability. The buffer stock requirement should be determined well in advance. The procurement process should be decentralised and FCI should act as the main coordinating agency. The MSP operations should extend to agriculturally underdeveloped regions, which have a vast unexploited potential for agricultural growth.
  • Procurement of foodgrains through competitive bidding for distribution to poor. Since these foodgrains will be distributed to poor at affordable price, competitive bidding will minimise the cost of procuring of foodgrains for the purpose. The management and coordination of the system should be done by a state level agency, which should determine the quantum of foodgrains to be procured based on pre-defined criteria. Food stamps should be introduced in certain areas. NGOs and other civil society organisations should be roped in to create awareness among consumers about their entitlements under the programme. A grievance redressal system should be established.
  • Maintain a list of beneficiaries with their contacts, etc and make it public (put it out on the website). Something along the lines of Food for Work Programme in Andhra Pradesh.

Role of FCI

Under the proposed  system, the FCI’s role would be to provide emergency buffer stock, the PDS part of its function could be gradually eliminated with the expansion of food coupon system.

Note on Food Stamps
(Reference: “Food Stamps: A Model for India”, Discussion Paper, Centre for Civil Society, November 2004)

Food stamps are used in many countries all over the world. They are proven to be a cost effective means to assure right quantity and quality of food for all. Each food stamp specifies the money amount that can be used to purchase approved food items from any regular or approved shops in the market. The shopkeeper presents the food stamps collected from the holders to the government to get the equivalent amount of money. With technological developments, countries have replaced paper food stamps with smart cards or debit cards, drastically reducing transaction costs, pilferage and corruption.

Food stamps provide an alternative to the PDS to ensure supply of food to the poor and the needy. Instead of putting grains in ration shops under the PDS, food stamps put purchasing power directly in the hands of the poor. The problem of foodstuff being sold in the black market would disappear because first, no separate ration shops need to be created since the food stamps can be accepted by regular approved shops, and second the shopkeeper would be able to collect food stamps only after giving the ration to the people. Food stamps offer better guarantee that the ration would reach the poor.

Poor targeting, excessive procurement, storage and distribution costs, and leakages or illegal diversions of subsidised grains are grave ills of PDS. Under the food coupons system, the FCI’s role would be only to provide emergency buffer stock, the PDS part of its function could be eliminated. Getting rid of this whole system would result in vast savings, which can be delivered to the poor through the better-targeted food stamp system.

A concern about food stamps is that it is a means of reducing the real value of subsidy. Since food stamps entitle households to generally a fixed value of purchase and not a fixed quantity, the criticism is that with inflation, the real value in terms of grain that can be purchased by the consumer falls. This concern can be tackled by indexing the food stamps to the inflation rate.

There is a fear the stamps will be sold and the money used to buy other things. A related concern is the issue of black marketing. But there isn’t much to stop a person from selling PDS grains to earn some money. After all, the shopkeepers have been doing that for so many years and selling the goods in the black market. In order to keep this risk at minimum it is necessary to ensure proper targeting of food stamps. Another way to reduce this risk is to not make denominations of stamps very big. With big denominations, beneficiaries wanting to space purchase over time or to purchase in different stores will need to cash food stamps.

Another concern relates to forgery and fraud. Introducing adequate security elements with regard to stamps and informing beneficiaries and food suppliers that security elements are in place, can reduce this problem. Introduction of rewards for detection of forged stamps can also help. Food stamps should also be dated in terms of redemption, which stops circulation for long periods Security paper, which makes stamp forgery more difficult, can be found in most central banks in developing countries, supplied by international secure paper providers. Printing houses are also available in Central Banks or other private or public offices.

The cost to consumers of picking up the stamps can be minimised by asking the targeted beneficiaries to pick them up at the local post office/ health centre. Similarly, they can also be redeemed at the local post office/ bank.

References:

  • Central Government Subsidies in India, Department of Economics Affairs, Ministry of Finance, Government of India, December 2004

  • Chand, Ramesh, Agriculture Markets in India: Implications for Competition, in Pradeep Mehta edited, “Towards a Functional Competition Policy for India”, CUTS, Academic Foundation, 2005

  • Food Stamps: A Model for India, Discussion Paper, Centre for Civil Society, November 2004

  • Das, Vidhya, Food Policy and Tribal Poverty, Agragamee.org

  • Swaminathan, Madhura, Targeted Food Stamps, Business Line, August 3, 2004